Board of Directors of State Bank of Pakistan: Second Quarterly Report - 2017

Transcription

1. THE STATE OF PAKISTAN ’S ECONOMY Second Quarterly Report for the year 2016-17 of the Board of Directors of State Bank of Pakistan State Bank of Pakistan
2. Acknowledgment Analysts : Chapters: 1. Overview Fida Hussain 2. Real Sector 3. Inflation and Monetary Policy 4. Fiscal Policy and Public Debt 5. External Sector Syed Sajid Ali; Javed Iqbal; Khurram Ashfaq Baluch Asma Khalid; Umer Khan Baloch; Talha Nadeem; Amjad Ali Fida Hussain; Dr. Muhammad Omer; Imtiaz Hussain; Muhammad Idrees Manzoor Hussain Malik; Syed Ali Raza Mehdi; Naila Iram; Junaid Kamal Formatting: Muhammad Idrees Publication Manager: Fida Hussain Director: Dr. M. Farooq Arby Publication Review Committees: PRC of the Management PRC of the Board Riaz Riazuddin (Chairman); Jameel Ahmad; Qasim Nawaz; Syed Irfan Ali; Syed Samar Husnain; Dr. Saeed Ahmed; Muhammad Ali Malik; Dr. M. Nadeem Hanif; Dr. Farooq Pasha; Dr. Jameel Ahmed; and Dr. M. Farooq Arby Ardeshir Khursheed Marker (Chairman); and Mohammad Riaz The feedback from Research, Monetary Policy and Statistics & Data Warehouse Departments, and logistic support by Office of the Corporate Secretary, and External Relations Department are also appreciated. For feedback and queries: quarterly.report@sbp.org.pk
3. Contents 1 Overview 1 .1 Economic review 1.2 Outlook for FY17 Page No. 1 3 7 2 2.1 2.2 2.3 2.4 Real Sector Overview Crop sector Large-scale manufacturing Services 9 9 9 11 18 3 3.1 3.2 3.3 3.4 3.5 Inflation and Monetary Policy Policy review Money market developments Monetary aggregates Credit to private sector Inflation 19 19 22 24 25 29 4 4.1 4.2 4.3 4.4 4.5 Fiscal Policy and Public Debt Overview Revenues Expenditure Provincial fiscal operations Public debt 33 33 34 39 40 41 5 5.1 5.2 5.3 5.4 5.5 External Sector Overview Current account Financial account Exchange rate Trade account 49 49 52 53 58 59 Annexure: Data explanatory notes Acronyms 67 71
4. 1 Overview The overall economic environment continues to remain conducive for growth . An accommodative monetary policy stance; increase in development spending; substantial growth in private sector credit, especially for fixed investment; and ongoing CPEC-inspired activity in power sector and infrastructure, are providing the needed support. Table 1.1: Selected Economic Indicators H1-FY16 H1-FY17P Growth rate (percent) LSM a 3.9 3.9 CPI (period average) 1, a 2.1 3.9 Private sector credit 2, b 7.4 8.6 Money supply (M2) 2, b 4.3 5.0 Exports a -14.5 -3.9 Imports a -7.9 10.1 Exchange rate (+app/-dep%) b -2.8 0.2 billion Rs Private sector credit 3 295.7 383.7 Tax revenue c 1,371 1,467 million US dollars SBP’s liquid reserves (end-period) b 15,884 18,272 Worker remittances b 9,688 9,458 FDI in Pakistan b 978 1,081 Current account balance b -1,865 -3,527 percent of GDP Fiscal balanced -1.7 -2.4 P Provisional estimate. 1 YoY growth in the average of CPI index for the quarter. 2 Percent change in December over June. 3 Flows since end-June Sources: a Pakistan Bureau of Statistics; b State Bank of Pakistan, c Federal Board of Revenue; and d Ministry of Finance. These factors have also led to an improvement in the investors’ confidence, which is particularly reflected in capacity expansion plans by a number of industries and acquisition of domestic companies by foreign investors.1 Meanwhile, recent pick up in the large-scale manufacturing (LSM) growth, improving energy supplies,2 and an increase in value-added textile exports in Q2-FY17 further add to the optimism.3 Moreover, agriculture growth is also likely to rebound as indicated by an increase in the production of major crops over the last year. 1 Several industries, including cement, steel, beverages, and automobiles, have announced capacity expansion plans; some of these are already underway. Moreover, in November 2016, a Turkish company acquired Pakistani home appliance firm Dawlance, and a Dutch food conglomerate completed its purchase of a majority stake in Engro Food in December 2016. More foreign investment is in the pipeline, particularly in construction-allied, automobile and food industries. 2 Two new power projects came online in December 2016 and February 2017, adding a cumulative 433 MW to the grid. Furthermore, a 1,320 MW coal power plant at Sahiwal has started trial operations, and the Chashma Nuclear Power Plant Unit-4 is expected to start its operation soon as well. In addition, overall gas supplies have also improved, enabled by an increase in LNG imports during H1-FY17 (Chapter 2). 3 After falling for last seven quarters consecutively, textile exports grew by 3.2 percent in Q2-FY17.
5. The State of Pakistan ’s Economy In addition to favorable spillover from commodity producing sectors, the current trends in key variables – like rising sale of commercial vehicles, oil consumption by the transport sector, internet subscription, external trade volume, etc. – reflect positively on the performance of the services sector. These developments suggest that the economy is maintaining its growth momentum. In this backdrop of increased domestic supplies, ongoing expansion in economy’s future capacity to produce, and muted impact of uptick in international commodity prices, inflation remained lower than the target. The low inflation also shows the impact of sustained decrease in fiscal deficit and stability in external sector over the last few years. However, these have started to show signs of strains recently. Specifically, the current account deficit in H1-FY17 was almost twice the level recorded in the first half of FY16. This was largely due to delayed realization of Coalition Support Fund (CSF), a decline in the exports, and a surge in the imports.4 From the external sector stability standpoint, such increase in the current account deficit does not bode well, particularly in view of bottoming out of global commodity prices (especially oil prices) along with some shifts in the international capital markets due to rise in the US interest rates. However, two points are important to consider about the external sector. First, the surge in imports is mainly concentrated in the growth-inducing capital goods: the import of machinery, fuel and metal groups accounted for more than half of the total imports during H1-FY17.5 When the economy is taking off, it is natural to expect some widening in the current account deficit. Nevertheless, it needs to be contained within sustainable levels. Second, the external inflows in the country have been sufficient to finance the current account deficit so far. More importantly, the current level of SBP’s foreign exchange reserves can comfortably finance more than five months of imports. On the fiscal side, coupled with increase in development spending and security related expenditures, the decline in revenue collection has led the fiscal deficit to widen by 0.7 percent of GDP in H1-FY17 as compared to the last year. Going forward, lower-than-expected growth in tax revenues could undermine the 4 Pakistan received US$ 550 million under CSF in two tranches: one in February 2017 (US$ 350 million) and the other in March 2017 (US$ 200 million). In FY16, US$ 713 million under CSF were received in the first half. 5 Within the machinery group, power generation machinery increased by 112.6 percent; textile machinery by 11.3 percent; construction and mining machinery by 54.8 percent; electrical machinery 7.5 percent; and, others by 29.4 percent. For more details, see Section 5.5. 2
6. Second Quarterly Report for FY17 government ’s efforts to keep the fiscal deficit at the targeted level and at the same time increase the development spending. The challenges in the external and fiscal accounts need to be addressed to sustain macroeconomic stability, which has just started to push the economy towards a desirable (low inflation-high growth) balance. In addition to boosting foreign exchange receipts from reviving exports and private foreign investment, urgent measures are needed to contain imports, especially of consumer and luxury items – to keep the overall import bill manageable.6 A combination of improved competitiveness and administrative measures would produce desirable results in this regard. In particular, there is a need to further reduce cost of doing business, enhance productivity, and remove structural impediments in the export sector. Similarly, the structural reforms and stabilization measures undertaken by the Government to reduce the fiscal deficit during the last three years need to be further deepened. In particular, the continuity of concerted efforts aimed at broadening the tax base is necessary to gear up momentum in revenue collection and create the fiscal space required for higher spending on social and infrastructural development. 1.1 Economic review Preliminary data on crops indicates that agriculture growth will rebound in FY17. The production of major kharif crops, including cotton, sugarcane, and maize is estimated to increase significantly this year. The output of major rabi crop, i.e., wheat is also expected to remain close to the last year’s bumper crop of 25.4 million tons on the back of timely and widespread rains.7 Besides improved water situation (from January 2017 onwards), an increase in fertilizer off take (33 percent higher), and higher credit disbursement (up 32 percent) during Rabi season also point to a better performance of the crops subsector. Encouragingly, LSM growth has picked up momentum in Q2-FY17 (rising by 5.8 percent YoY). This partly compensated the sluggish Q1-FY17 growth of 2.1 percent. As a result, the cumulative growth during H1-FY17 increased to 3.9 percent, same as the last year. The major contribution to LSM growth during H1FY17 came from food, steel, cement and pharmaceutical industries. 6 In order to contain import growth, SBP has imposed 100 percent cash margin on import of consumer and luxury items (BPRD Circular No. 02 of 2017, dated 24 February 2017). 7 Although there are reports of a slight decline in area under cultivation due to dry weather and water shortages during the sowing season in barani areas, this is likely to be partially offset by the expected increase in productivity. 3
7. The State of Pakistan ’s Economy These industries largely benefited from accommodative monetary and fiscal policies; improved energy supplies; better availability of raw materials (e.g., sugarcane); rising domestic demand (particularly for cement and steel, owing to ongoing CPEC-related power and infrastructure projects); and clarity on drug pricing mechanism. In addition, the recently announced export package would also provide much needed support to export industries, especially textile – the historical mainstay of LSM growth. On the other hand, the available information on services sector indicators points to a mixed performance. Healthy trends in transport (given the surge in sales of trucks, buses, and POL products); increased (external) trade volumes along with better output of agriculture and industry (having positive spillover for wholesale and retail trade); significant increase in bank credit; and a rise in 3G/4G subscription base (27 percent) during H1-FY17, all indicate towards an uptick in the services sector’s performance. At the same time, losses of Public Sector Enterprises (PSEs), and a decrease in banks’ profitability, act as potential drags. On balance, however, the services sector is expected to keep up last year’s growth momentum (see Chapter 2 for details). Meanwhile, ongoing investments in energy and infrastructure sectors (and strong transport sector activity) resulted in a sharp increase in import demand, especially for capital goods and raw materials. Led by higher imports of machinery (power and construction) and petroleum (including LNG), the total import bill grew by 6.0 percent during H1-FY17, compared to 8.9 percent decline in the corresponding period last year.8 This surge in imports was partly a result of rising commodity prices, especially crude and palm oil. This, combined with the non-receipt of CSF in H1-FY17 and decline in exports and remittances, resulted in the almost doubling of the current account deficit to US$ 3.5 billion during first half of the year. (Here, it is worth mentioning that the receipt of CSF in Q3-FY17, and recently announced package for exports may help balance of payments going forward.) Encouragingly, available financial inflows were more than sufficient to finance the higher current account deficit. Major foreign exchange inflows included US$ 1 billion from a Sukuk and net loans of US$ 1.4 billion (including US$ 900 8 The increase was mainly concentrated in Q2-FY17, when import payments rose sharply by 11.5 percent YoY. In addition to elevated non-oil imports, POL imports rebounded for the first time since Q1-FY15 (on YoY basis) and contributed significantly to the rise in the overall import bill during Q2-FY17. 4
8. Second Quarterly Report for FY17 million of commercial borrowings ). In addition, net FDI increased by 10.5 percent to US$ 1.1 billion during H1-FY17, from US$ 978 million last year. As a result, SBP’s liquid FX reserves recorded a net increase of US$ 129 million during H1-FY17 (see Chapter 5 for details). Here, it must be acknowledged that while imports are essential at the moment to address infrastructure and energy bottlenecks, there is a need for an equivalent increase in foreign exchange earnings to finance these imports and thereby maintain the external sector’s stability. The official foreign inflows also helped financing of the fiscal deficit, which was 2.4 percent of GDP during H1-FY17 compared to 1.7 percent in the corresponding period last year. Both an increase in expenditures and a decline in revenues contributed to this widening of fiscal deficit. The decline in total revenue was largely due to 31.8 percent fall in non-tax revenue on account of non-realization of CSF in H1-FY17, lower SBP profit, and a decline in dividend income. Moreover, growth in tax revenue also decelerated to 6.2 percent during H1-FY17 compared to over 20 percent increase in the last year. This slowdown seems to be an unintended consequence of various tax measures to support investment, growth, and exports. Notwithstanding these factors, the need to address structural weaknesses in the tax system for a sustainable increase in tax revenue, commensurate with development and social spending requirements cannot be overemphasized. On the expenditure side, overall spending accelerated to 10.7 percent during H1FY17 – more than twice the growth of 5.0 percent recorded in H1-FY16. The pattern of expenditure shows that the government is largely maintaining its focus on improving the security situation and providing a boost to investment and economic activity through higher development spending. Spending on these two accounts grew by 10.9 percent and 16.7 percent respectively during the period under review (see Chapter 4 for details). Notwithstanding the higher fiscal deficit, the public debt increased by only Rs 583.4 billion during H1-FY17; this was almost half of Rs 1,097.7 billion increase observed in the corresponding period of the last year. The slowdown in debt accumulation was caused by deceleration in both the external and domestic debt. The net increase in public external debt and liabilities during H1-FY17 amounted to only US$ 130 million, against an increase of US$ 2.3 billion in H1-FY16. This slowdown in external debt accumulation reflected revaluation gains, mostly due 5
9. The State of Pakistan ’s Economy to the depreciation of the Japanese yen against the US dollar. On the other hand, the government retired its domestic debt to the tune of Rs 193.2 billion during Q2-FY17, as it utilized a large part of its deposits held with the banking system instead of resorting to fresh borrowing. As the economic activities are picking up the domestic demand is also rising (see Chapter 2 for detail). This, along with the revival in global commodity and oil prices, has pushed up average CPI inflation to 3.9 percent during H1-FY17 from 2.1 percent in H1-FY16. However, the year-on-year inflation fluctuated in a narrow range around 4.0 percent since the start of the fiscal year. In fact, a limited pass-through of the rise in global oil prices to domestic POL prices during H1-FY17 partially offset upward pressures stemming from higher food prices (especially of fresh vegetables and edible oil). Keeping in view the prevailing economic trends, i.e., healthy economic growth, contained inflation and at the same time increasing current account deficit, the Monetary Policy Committee (MPC) decided to keep the policy rate unchanged at 5.75 percent during H1-FY17. This, combined with a comfortable liquidity position in the interbank market, led to a continuation of stable market interest rates. These developments in the banking system induced growth in the private sector credit. The overall credit to the private sector increased by Rs 383.7 billion during H1-FY17 against an expansion of Rs 295.7 billion in the same period last year. A part of this reflects an increase in working capital requirements of manufacturing firms, in view of the rise in the raw material prices. Credit for fixed investment, i.e., the amount borrowed mainly for capacity expansion, also grew sharply following an increase in the public sector development spending. Besides hefty corporate sector borrowing, consumer loans also picked up. As mentioned earlier, the encouraging trend in private sector credit was partly supported by a hefty retirement of Rs 485.5 billion (on cash basis) by the government to commercial banks. A sizeable portion of this, Rs 212.6 billion, was due to maturity of Ijara Sukuk, and the rest came from low turnover in auctions of government securities. The retirement to commercial banks was made possible through the government’s recourse to borrowings from SBP and external sources.9 9 Government borrowing from SBP (on cash basis) increased by Rs 892.6 billion during H1-FY17, against a retirement of Rs 429.2 billion witnessed in the corresponding period of last year. 6
10. Second Quarterly Report for FY17 To a great extent , SBP neutralized the impact of the increase in the government’s borrowing on reserve money growth by scaling down the outstanding stock of OMO injections.10 This helped contain the reserve money growth to 6.6 percent in H1-FY17, against 10.6 percent recorded in the corresponding period of last year. Nevertheless, growth in broad money accelerated to 5.0 percent during H1FY17 from 4.3 percent last year. This growth came entirely from an expansion in Net Domestic Assets (NDA) of the banking system. On the other hand, Net Foreign Assets (NFA) of the banking system saw a contraction of Rs 20.6 billion in H1-FY17, against an expansion of Rs 150.6 billion seen last year. Although most of the contraction was contributed by scheduled banks, NFA of the SBP also declined by Rs 3.4 billion in Q2-FY17. 1.3 Outlook for FY17 The real GDP growth in FY17 is expected to be higher than the last year. Major contribution is expected from the rebound in agriculture and increased pace of work on infrastructure and energy projects. In particular, the completion of early harvest energy projects under CPEC is expected to provide additional boost to industrial growth. These expectations are in line with continuing robust trends in private sector credit and import of machinery and raw materials. The growth in industry, though likely to fall short of its target, is expected to maintain last year’s level. The textile industry, the largest sub-component of the LSM, is expected to post some recovery in H2-FY17, as exporters cash-flow constraints may ease following the recently announced export package. The commencement of operations of new power plants and the sustained increase in LNG imports are expected to help electricity generation and gas distribution to maintain last year’s momentum. Similarly, as indicated by strong trends in cement and steel production, the growth in construction sector is likely to remain robust in FY17 as well. The services sector, though showing a mixed trend as discussed in Chapter 2, is expected to achieve its target growth rate for the year. The current trends in trade, especially imports; higher production and sale of commercial vehicles; substantial increase in bank credit; flourishing housing schemes; and rising internet subscription, all suggest a vibrant services sector. Incorporating these developments, the latest projections indicate real GDP growth in the range of 5 to 6 percent in FY17 (Table 1.2). 10 The net outstanding stock of OMO injections was brought down from the peak of Rs 2,033.4 billion in mid July 2016 to Rs 800 billion by end-December 2016. 7
11. The State of Pakistan ’s Economy Increase in agriculture Table 1.2: Key Macroeconomic Targets and Projections production and sufficient food FY17 FY16 supplies, stable exchange rate, Target1 Projection2 and a limited pass-through of percent growth rising international Real GDP 4.74 5.7 5.0 – 6.0 CPI (average) 2.94 6.0 4.0 – 5.0 commodity prices to domestic billion US$ prices are expected to keep Remittances 19.92 20.2 19.5 – 20.5 inflation low and stable. 2 Exports (fob) 22.0 24.7 21.5 – 22.5 Importantly, in case of oil Imports (fob) 40.32 45.2 42.0 – 43.0 prices, less-than-warranted percent of GDP increase in domestic motor Fiscal deficit 4.63 3.83 4.0 – 5.0 fuel prices would limit its Current a/c deficit 1.22 1.5 1.0 – 2.0 direct and second round Sources: 1 Planning Commission; 2 State Bank of Pakistan; 3 impact on CPI inflation. Ministry of Finance; 4 Pakistan Bureau of Statistics. Moreover, the recent increase in investment demand as reflected by the widening of twin deficits may not have an adverse impact on inflation in the remaining months of FY17. Therefore, fullyear average CPI inflation is expected to remain in 4 to 5 percent range. In view of strong growth in imports and taking stock of developments in international commodity prices and global economic trends, the current account deficit is likely to increase; however, the country’s foreign exchange reserves will remain at comfortable level. Some gains in exports due to the recently announced export package are expected to be offset by muted remittance growth. Declining number of migrant workers going to the GCC (reflecting stressed fiscal conditions in these countries due to low oil prices); the pound sterling’s depreciation against the US dollar, and stricter regulatory controls in US, are the main factors that will likely keep remittance inflows close to last year’s level.11 Given the actual fiscal deficit of 2.4 percent of GDP in the first half, and keeping in view that the deficit is usually higher in the second half, the full-year fiscal gap will be higher than the target of 3.8 percent. This projection incorporates the impact of the recently announced export package, and assumes no significant change in the current pace of revenue collection in the absence of additional revenue generating measures. On the other hand, expenditures are likely to remain elevated due to the government’s commitment to complete most of the power and infrastructure projects by close of FY18 and ongoing operations aimed to further improve the country’s security environment. 11 The recent decision of Kuwait government to lift restrictions on issuing visas to Pakistani nationals bodes well for increased remittance flows going forward. 8
12. 2 Real Sector 2 .1 Overview The highlight of the second quarter for FY17 was the recovery in large-scale manufacturing (LSM) growth to 5.8 percent, from 4.0 percent in the corresponding period of FY16. As a result, LSM growth for H1-FY17 reached 3.9 percent – the same level as last year. In agriculture, healthier crop production would help the sector rebound from the decline recorded last year. Meanwhile, we expect the services sector to maintain last year’s growth momentum, based on an encouraging picture of wholesale and retail trade and transport. Thus, in overall terms, the GDP growth for FY17 is set to exceed last year’s level. 2.2 Crop sector While a better harvest of Table 2.1: Wheat Targets for FY17 sugarcane and cotton Area Yield Production (000 hectare) (kg per hectare) (000 tons) (compared to the last year) 3-Year FY17 3-Year FY17 3-Year FY17 provided a much-needed avg target avg target avg target impetus to the crop sector Punjab 6,940 6,800 2,813 2,868 19,520 19,500 during the kharif season, initial Sindh 1,128 1,150 3,372 3,652 3,802 4,200 reports on the wheat crop KP 765 760 1,726 1,842 1,321 1,400 suggest its production would Balochistan 373 400 2,344 2,250 873 900 remain close to last year’s Pakistan 9,205 9,100 2,772 2,857 25,516 26,000 level of 25.4 million tons – Source: Pakistan Agriculture Statistics; and SUPARCO slightly lower than the target of 26 million tons for FY17 (Table 2.1).1 Notwithstanding water shortages witnessed during the early part of the rabi season (Box 2.1), the situation eased considerably in January 2017 after prolonged and widespread rains throughout the country. This, coupled with extended spells of low temperature and better availability of other inputs (fertilizer and credit), is likely to have a positive effect on wheat output.2,3 1 The Annual Plan 2016-17 set the wheat production target at 27.4 million tons, which was later revised down to 26 million tons by the Federal Committee on Agriculture. This target assumes a crop yield of 2,857 kg per hectare, which is higher than the average yield of 2,772 kg per hectare recorded during the past 3 years. 2 In the Federal Budget 2016-17, the government had announced a cash subsidy of Rs 156 per bag on urea and Rs 300 per bag of DAP, at an estimated cost of Rs 27.16 billion (Rs 17.16 billion for urea
13. The State of Pakistan ’s Economy In the meantime, low precipitation in the country further stressed water resources.4 The rain-fed areas under wheat account for 13.2 percent of total area under the crop, and contribute 6 percent to the total output (Table 2.1.1). That said, the subsequent heavy rainfall in January 2017 provided a major relief to the crop sector. 21 000 millimeter 4.5 19 17 3 Source: SUPARCO Jan Dec 0 Nov FY17 FY16 FY15 FY14 15 Oct 1.5 FY13 Specifically, irrigation water supply to Punjab and Sindh, which together account for more than 85 percent of the area under wheat, contracted by 8.1 percent during Oct 2016-Jan 2017 (Figure 2.1.1). This was on top of the 5.2 percent YoY decline recorded during the corresponding period of the previous year. Figure 2.1.1: Irrigation Water Aggregate Rainfall in Punjab & Sindh(oct-Jan) FY16 FY17 6 23 million acre feet Box 2.1: Water Availability in Early Rabi The irrigation water shortages and prolonged dry spell during the early rabi season led to some decline in the sowing area under the wheat crop (particularly in rain-fed regions of the country). Source: IRSA Table 2.1.1: Wheat Performance for Rain-Fed Areas (Average 2010-11 to 2014-15) Rain-fed area Output from Yield of rainunder wheat rain fed area fed area (as % of total area under crop) (as % of total production) (as % of yield for irrigated land) Punjab 10.2 4.7 42.9 Sindh 4.7 1.2 24.8 KP 55.9 43.0 59.4 Balochistan 7.9 4.7 57.1 Total 13.2 6.0 42.1 Source: Agriculture Statistics of Pakistan, Ministry of National Food Security & Research With the expected output reaching last year’s level, FY17 may be another year when domestic wheat production would exceed domestic consumption. This, in turn, would further augment wheat stocks available with government agencies.5 This situation has arisen at a time when the Food and Agriculture Organization (FAO) is already expecting record global wheat output this year. As a result, the wheat glut in the and Rs 10.8 billion for DAP fertilizer). This cost was to be shared equally by the federal and the provincial governments. In addition, the government also reduced the GST on urea from 17 percent to 5 percent. These measures pulled down urea and DAP prices by 28 and 27 percent respectively. 3 Gross credit disbursement to agriculture sector grew by an impressive 32 percent in the ongoing Rabi season – both development and production loans contributed to this increase. 4 In Q2-FY17, the country recorded nearly 90 percent less rainfall as compared to the same period last year. 5 It may be noted that wheat stocks with government agencies have been rising consistently over the past few years, and reached 8.0 million tons by end-January 2017, from 3.75 million tons at endJanuary 2014. 10
14. Second Quarterly Report for FY17 2 .3 Large-scale manufacturing (LSM) LSM recorded a growth of 3.9 percent during H1-FY17, the same level realized last year (Table 2.2). After a dull first quarter (Figure 2.2), the recovery in LSM growth in Q2-FY17 came from food, steel, cement, pharmaceutical, automobiles and electronic industries. Figure 2.1: Wheat Prices Difference 400 Domestic prices Global prices US$ per mt 300 200 100 0 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 FY15 FY16 FY17 Source: Pakistan Bureau of Statistics and World Bank Figure 2.2: YoY Growth in LSM Excluding sugar Overall 14 7 percent international market is likely to deepen further, with stocks projected to reach a record 248 million tons by year-end. The resulting downward pressures on international wheat prices will pose a challenge for Pakistan as well, as this will make it difficult for the country to export the surplus wheat, even in the presence of sizeable government subsidies (Figure 2.1).6 0 -7 Jul-15 Aug-15 Sep-15 Oct-15 Nov-15 Dec-15 Jan-16 Feb-16 Mar-16 Apr-16 May-16 Jun-16 Jul-16 Aug-16 Sep-16 Oct-16 Nov-16 Dec-16 Going forward, multiple factors are likely to provide further impetus to LSM Source: Pakistan Bureau of Statistics growth. These include supportive economic policies (low interest rate and higher PSDP spending); recently announced incentives for export industries;7 improved energy supplies;8 6 The government has permitted the export of 0.9 million tons of wheat, with a subsidy of US$ 120 per ton. So far, no significant exports have taken place, as Pakistan’s FOB wheat price (even after adjustment for export subsidy) is still significantly higher than its closest competitors. 7 The government recently announced an export stimulus package of Rs 180 billion (for H2-FY17 and FY18). This package offers several incentives, including removal of duty and taxes on some raw material and machinery, and rebate on exports, etc. 8 LNG imports increased to 1,004 MT during H1-FY17 against 400 MT during the same period last year. The new Chashma Nuclear Power Plant (Unit-3) has added 315 MW electricity to the system. 11
15. The State of Pakistan ’s Economy strong domestic consumer demand;9 and an uptick in private sector credit for fixed investment purposes.10 Furthermore, the constraints that inhibited the growth of some industries in Q1-FY17, are expected to dilute in the future.11 Having said this, a sharp revival in LSM might be constrained by a number of factors: (1) Most of the industries that have shown steady growth over the past few years (e.g., cement, autos, steel and pharmaceutical), have already achieved high levels of capacity utilization – further growth would therefore require capacity expansions;12 Table 2.2: YoY Growth in LSM (Jul-Dec) YoY growth wt. FY16 LSM 70.3 3.9 Textile 21.0 1.0 Cotton yarn 13.0 1.8 Cotton cloth 7.2 0.7 Jute goods 0.3 -22.6 Food 12.4 -0.1 Sugar 3.5 -14.2 Cigarettes 2.1 -10.6 Vegetable ghee 1.1 4.9 Cooking oil 2.2 6.4 Soft drinks 0.9 4.0 POL 5.5 6.8 Steel 5.4 -8.6 Non-metallic 5.4 7.1 minerals Cement 5.3 7.1 Automobile 4.6 32.4 Jeeps and cars 2.8 47.2 Fertiliser 4.4 15.1 Pharmaceutical 3.6 7.2 Paper 2.3 -15.6 Electronics 2.0 -8.2 Chemicals 1.7 10.8 Caustic soda 0.4 26.1 Leather products 0.9 6.2 LSM excl. sugar 66.8 4.4 Source: Pakistan Bureau of Statistics FY17 3.9 0.1 0.4 0.2 -38.6 6.9 52.4 -31.0 2.3 -0.5 18.8 -1.3 15.6 9.3 9.6 6.7 -2.7 3.5 7.9 5.7 14.5 -2.7 -6.3 -18.9 2.6 Contribution in growth FY16 FY17 0.30 0.36 0.06 -0.08 -0.01 -0.43 -0.23 0.07 0.24 0.11 0.45 -0.33 0.75 0.75 1.73 1.22 0.90 0.60 -0.64 -0.14 0.27 0.11 0.12 -- 0.04 0.08 0.02 -0.10 1.16 1.32 -0.58 0.03 -0.02 0.52 -0.09 0.53 1.02 1.03 0.45 -0.10 0.23 0.68 0.19 0.22 -0.07 -0.03 -0.38 -- (2) In the textile sector, the recovery in global commodity prices (particularly cotton) and the recently announced export package are positive developments. But fully capitalizing on these favorable developments would require a wellGoing forward, 1,320 MW coal fired power projects at Sahiwal and the 118 MW Port Qasim power project in Karachi would further ease the energy constraints. 9 Several indicators show rising consumer demand in the country, like: (i) a rise in consumer financing; increase in the sale of consumer durables (automobiles, electronic goods); sharp growth in fuel consumption, etc. Furthermore, the IBA-SBP Consumer Confidence Index (CCI) recorded its highest-ever level of 174.9 points in January 2017, showing an increase of 17 points from July 2016. 10 During H1-FY17, the manufacturing sector availed Rs 82.7 billion in fixed investment loans, against Rs 21.8 billion in the same period last year. 11 Some of these include: withdrawal of the increase in Federal Excise Duty on cigarettes (announced in the federal budget FY17, which led to a decline in production during Q1-FY17); and the lifting of a temporary ban on jute exports by Bangladesh (which had adversely affected the local jute industry). Similarly, the post-Apna Rozgar Scheme drag on car production would fade away after February 2017 (as car production under this scheme had continued till February 2016). 12 While several firms in cement, steel, automobiles and beverages industries have already planned capacity expansions, it may take time for them to materialize. 12
16. Second Quarterly Report for FY17 (3) Global prices of key raw materials are increasing, which may squeeze margins for manufacturing firms in cement, automobiles, and cooking oil/ghee sectors (Table 2.3). Sectoral review Cement The growth in cement production increased to 9.5 percent during H1-FY17 from 7.1 percent in H1-FY16. This was mainly a result of robust domestic demand, as exports to Afghanistan fell due to strong competition from cheaper Iranian cement and some supply-related issues (Figure 2.3).14 During H1FY17, overall cement sales grew 8.7 percent and reached a record level of 19.8 million metric tons.15 Table 2.3: Key International Raw Material Prices Change over (percent) Commodities US$* 3-months 6-months 12-months Coal (mt) 87.2 28.9 45.2 76.9 Palm oil (mt) 711.8 2.8 21.8 36.7 Soya bean Oil (mt) 800.3 10.7 19.5 18.2 Cotton (lb) 71 3.1 8.3 8.7 Copper (mt) 251 12.9 12.3 16.1 Steel (lb) 633 27.6 2.9 61.9 Iron (mt) 79.7 40.7 41.0 101.4 Rubber (kg) 200 43.9 54.8 69.9 Crude oil Brent (bbl) 52.6 16.8 19.0 43.9 WTI (bbl) 54.9 21.5 22.9 47.5 Arabian light (bbl) 52.6 23.3 21.6 56.4 * As of 31st December, 2016 Source: Bloomberg, IMF and WB Figure 2.3: Cement Sales (Jul-Dec) Exports Domestic Total 24 18 million tons thought out strategy and concerted efforts to resolve the endemic issues afflicting the sector;13 and 12 6 0 FY14 FY15 FY16 FY17 Source: All Pakistan Cement Manufacturers Association 13 Efforts are needed to address the issues, like low investment on R&D, product development, innovation, branding and tapping of new markets; lack of skill upgradation and resulting low labor productivity; use of obsolete technology; and high export concentration in low value added products. 14 Due to implementation of border management system and some other issues, the resultant delays in transportation of cement (which has limited shelf life) has forced Afghan buyers to switch to Iranian cement. 15 Domestic sales recorded a double-digit growth of 11 percent and reached 16.9 million tons in H1FY17. Cement exports, on the other hand, declined by 4 percent during this period. 13
17. The State of Pakistan ’s Economy The sizable domestic demand actually allowed manufacturers to enhance their capacity utilization to over 80 percent. The resulting economies of scales also improved their margins. The outlook of the industry appears encouraging, as many cement producers have announced capacity expansions in anticipation of firm demand (from private housing schemes, rising development spending and increased focus on CPEC-related projects).16 Figure 2.4: Trend in Private Steel Production Billets H.R sheets/strips Total 32 24 percent Steel Robust construction activities in the country also led to an increase in demand for steel and allied products. The production of steel grew by 15.6 percent during H1-FY17 (Figure 2.4). More importantly, this growth was achieved despite the dumping of cheaper Chinese imports (which squeezed margins for the local industry). 16 8 0 FY13 FY14 FY15 FY16 H1-FY17 That said, the industry gained Source: Pakistan Bureau of Statistics some comfort when a recovery in global prices offered local players a room to increase their prices as well.17 At the same time, improved energy supply helped the industry improve its capacity utilization. Expecting strong domestic demand going forward, the industry is gearing up for expansions as well. For example, some large steel producers are doubling their production capacities, in addition to diversifying their energy mix and minimizing their dependence on imported raw materials. The outlook for the local industry has further improved following the imposition of anti-dumping duties on imports of steel products from China.,18 16 The establishment of the proposed infrastructure finance bank (in partnership with international financial institutions to finance mega infrastructure projects in the private sector) could prove instrumental in ensuring the sustainability momentum of construction activities in the country. 17 Following rising international prices, domestic steel prices also increased by Rs 3,000-5,000 per ton. 18 In February 2017, the National Tariff Commission (NTC) imposed anti-dumping duties on imports of steel products (galvanised steel coils and sheets), in the range of 6 percent to 40.5 percent. Other countries have also imposed anti-dumping and countervailing duties on steel imports from China. 14
18. Second Quarterly Report for FY17 Automobiles The automobile sector registered a YoY growth of 6 .7 percent in H1-FY17, compared to an increase of 32.4 percent in the corresponding period last year. Higher production of vehicles under the Apna Rozgar Scheme last year explains this slowdown in growth.19 Adjusting for this scheme, the auto industry showed a reasonable growth of 11.0 percent YoY during H1-FY17 (Table 2.4). This was largely enabled by higher sales of commercial vehicles (i.e., tractors, trucks and buses). Table 2.4: Vehicles Production and Sale %Growth H1-FY16 H1-FY17 H1-FY16 H1-FY17 Output Sale Output Sale Output Sale Output Sale 90,222 85,901 92,514 89,824 -2.5 -4.4 48.0 53.0 79,803 76,288 72,847 70,308 9.5 8.5 31.5 35.1 3,806 3,304 2,326 2,194 63.6 50.6 31.8 34.7 669 577 499 451 34.1 27.9 65.8 76.9 12,548 11,427 21,423 21,474 -41.4 -46.8 144.6 164.2 2,829 2,533 2,552 2,522 10.9 0.4 20.0 39.9 21,336 20,933 13,064 12,375 63.3 69.2 -45.9 -40.7 Units Passenger Cars Exc. Apna Rozgar Scheme Trucks Buses LCVs, Vans & Jeeps Exc. Apna Rozgar Scheme Farm Tractors Motorcycles & ThreeWheelers 790,240 789,879 657,283 651,338 Source: Pakistan Automotive Manufacturers Association 20.2 21.3 86.2 84.1 The robust growth in tractors was mainly due to an improvement in the purchasing power of growers due to better prices of rice and cotton; cash disbursement on account of kissan package; subsidy on basic inputs like fertilizer; and a reduction in sales tax on tractors. Similarly, the production of trucks and buses segment has responded to expansion in road infrastructure, and growing trade and economic activities. Going forward, the industry is also expected to benefit from the launch of new models (e.g. Celerio, Alto 660cc, Revo, Fortuner, Ciaz and Vitara) by existing manufacturers; the revival of dormant players Kia Motors and Hyundai; and the entry of new players. Steel manufacturers have also been able to persuade China to cut down its production. As a result, Chinese steel exports fell during CY-16, providing support to prices in the international market. 19 The effect of the Apna Rozgar Scheme, which had inflated last year’s growth number for the passenger car segment, is going to end in February 2017. This will help normalize the segment’s growth going forward. 15
19. The State of Pakistan ’s Economy Fertilizer The buildup of large urea inventories last year took its toll on domestic production this year, as output grew by 3.5 percent during H1-FY17, significantly lower than the 15.1 percent rise witnessed in H1-FY16. Despite some recovery in sales during Q2-FY17 (due to lower prices), urea stocks were still quite elevated at about one million tons by end-December 2016.20 Going forward, domestic demand is expected to remain strong in response to the government’s decision to maintain subsidy on fertilizer.21 Moreover, production would also benefit as the industry is getting adequate gas supplies. Pharmaceuticals The pharmaceutical industry continued its growth momentum from last year, rising by 7.9 percent during H1-FY17. A number of factors helped the industry’s growth, like price hikes last year; a decline in raw material costs (due to the euro’s depreciation); and ongoing consolidation in the sector.22,23 Multiple factors, including the current state of health facilities and the government’s increased focus on the sector; higher population growth; more clarity after the drug pricing policy; and the launch of new products (like the dengue vaccine) can further fuel the industry’s growth. Electronics This segment witnessed a sharp turnaround during H1- FY17, recording a growth of 14.5 percent, against a contraction of 8.2 percent during the same period last year. Consumer durables like refrigerators (up 25.0 percent) and deep-freezers (up 54.4 percent) mainly contributed to this improved performance. Further rise in energy supply in the coming months, increase in consumer financing in a low interest rate environment, better market access for the rural population, expansionary plans of leading players, and foreign investment, all indicate a sustainable trajectory for the industry’s growth going forward.24 20 Urea inventories reached 1.3 million tons by end-September 2016. Although the government has allowed the export of 0.3 million tons of urea in FY17, its higher cost makes exports challenging: domestic prices are still at a premium of 6 percent to international prices). 22 ICI Pakistan Limited is in the process of acquiring the assets of Wyeth Pakistan Limited, a multinational pharmaceutical company operating in Pakistan since 1949. And Martin Dow Ltd has acquired the Pakistani operations of Merck KGaA. 23 The gross margins for the industry crossed 30 percent in H1-FY17 (source: listed companies’ financial reports). 24 Turkish firm Arcelik has recently acquired the home appliance company Dawlance Pakistan for US$258mn. 21 16
20. Second Quarterly Report for FY17 Food During H1-FY17 , the food sector grew by 6.9 percent, after contracting by a marginal 0.1 percent in H1-FY16. While cigarette-manufacturing continued to decline (in response to the levying of FED in the FY17 budget), a sharp increase in sugar production supported the overall growth in the food industry. 30 28 67 27 63 26 59 25 55 24 Jul-15 Aug-15 Sep-15 Oct-15 Nov-15 Dec-15 Jan-16 Feb-16 Mar-16 Apr-16 May-16 Jun-16 Jul-16 Aug-16 Sep-16 Oct-16 Nov-16 Dec-16 71 US cent per pound Figure 2.5: Trend in Sugar Prices Domestic International (rhs) 75 rupees per kg A better sugarcane crop, and rising domestic prices of sugar, led to an increase in cane crushing.25 In addition, the government has allowed the export of 0.225 million tons of sugar.26 These exports have now become increasingly feasible, given the rise in global sugar prices during H1FY17 (Figure 2.5). In addition, manufacturers have increased their focus on power generation through byproducts (mainly bagasse and ethanol). Source: Pakistan Bureau of Statistics and World Bank The soft drink category grew by 18.8 percent during H1-FY17 – higher than the average growth of 16 percent realized in the last five years. A major soft drink firm recently made a US$ 200 million investment to expand its production and distribution capacities. On the other hand, volatility in international cooking oil prices and the drive against hazardous and low quality oil, constrained the production of vegetable ghee and cooking oil. Textile The growth in the textile industry remained subdued at 0.1 percent during H1FY17, compared to 1.0 percent in the corresponding period last year. The export decline and structural bottlenecks constrained the performance of the sector. While the government has recently announced a generous export package for the 25 While sugarcane output is likely to reach an all-time high of 71 million tons, domestic sugar prices have risen by 11 percent YoY during Jul-Jan FY17. 26 An inter-ministerial committee would meet in the first week of every month to review the price and stock/export situation of sugar. In case domestic prices exceed their level on December 15, 2016, the committee would recommend to the ECC to stop further exports of the commodity. 17